Posted By Don Boudreaux On July 17, 2011 @ 4:01 pm In Balance of Payments,Growth,Myths and Fallacies,Trade | Comments Disabled

In the unreported parts of his e-conversation with the protectionist Ian Fletcher,[1] David Henderson very likely made the following point. But because David didn’t quote that part of his e-debate with Fletcher, I take the opportunity here to highlight another critical way in which Fletcher is just plain wrong. Fletcher writes:

First, you [Henderson] seem to contend that FDI [foreign direct investment] is an exception to the basic rule in economics that, in Milton Friedman’s words, “there is no free lunch.” That is, you ignore the fact that when foreigners make an investment in the U.S., they own the investment. That the investment took place may be a good thing, but this doesn’t change that fact that when foreigners, rather than Americans, own an investment, this increases the net worth of foreigners and reduces the net worth of Americans by the same amount.

Wrong. There is no reason to conclude that the net worth of Americans is reduced by any amount. It is not a “fact” that an increase in FDI in the U.S. increases the net wealth of the foreign investor by some $$ amount and decreases that of some American (or Americans as a group) by the same $$ amount. Any number of examples might suffice to show why Fletcher is utterly off-base to make such an assertion. Here’s a straightforward one:

Suppose my neighbor Smith sells his vacant lot in Virginia for $100,000 to Mr. Lee from China. Mr. Lee then grows corn on that lot and earns profits from doing so. Mr. Lee’s net worth rises. Has my neighbor’s net worth declined? Possibly – if he spends the $100,000 on consumption goods (which, as David ably argues, is not necessarily a bad thing; what, after all, is the ultimate goal of economic activity if not to be able to consume more?).

But “possibly” is not “necessarily,” or even “probably.” If Smith spends the $100,000 to pay his way through medical school or to invest in his sister-in-law’s new business venture that turns out to be quite successful, Smith’s net worth increases. It might increase by more (or by less – it doesn’t really matter) than the increase in the net wealth of Mr. Lee.

Mr. Lee is richer. Smith is richer. No American is poorer. No foreigner is poorer. And Lee’s customers are richer (they get more or better or less costly corn as a result of Lee’s efforts), as are Dr. Smith’s patients or the customers of Sister Smith’s booming new business.

Fletcher’s mind seems so stuck in a zero-sum gear that he misses this not-at-all far-fetched possibility.

Or look at the matter from a different perspective by asking what would happen to Americans’ net wealth if foreigners were to completely remove themselves – or be completely removed by Congress – from the pool of potential investors in dollar-denominated assets. Would the value of publicly traded corporate shares currently owned by Americans rise? Would the value of real estate currently owned by Americans rise? Would the value of successful American start-up companies rise?

I gather that Ian Fletcher believes that the answer to these questions is an unambiguous “yes.” Do you?

…

There are ways other than the one I highlighted in my above example with Smith and Lee that FDI in America results in increases in both the net wealth of foreign investors and in the net wealth of Americans. Take a stab in the comments section offering examples.